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"Top Ten Common Bankruptcy Issues Facing Corporate Counsel," Association of Corporate Counsel, 2011

December 1, 2011

If you have received notice that your company’s customer or vendor has filed for bankruptcy, the next logical question is "what does this mean for my company?" This outline is intended to address the 10 most common situations a company may find itself in when a debtor files for chapter 7 (liquidation) or chapter 11 (reorganization) bankruptcy. Each of the questions addressed below includes tips for evaluating relevant issues and recommendations for proceeding.

1. Can I Still Do Business With the Debtor and What Are My Risks?
In chapter 11 bankruptcy, the debtor remains in possession and control of its assets and can continue to operate its business and conduct transactions in the ordinary course of its business. Transactions outside the ordinary course of its business, including those a debtor only occasionally engages in such as selling off a part of its business or entering into a credit facility, require advance bankruptcy court approval. There may be less risk extending credit to a chapter 11 debtor because all "post-petition" debts constitute priority "administrative claims" that are paid in full prior to any distribution to unsecured creditors, but some estates can become administratively insolvent if secured creditors are owed more than the value of their collateral.

In chapter 7 bankruptcy, the debtor ceases operating its business and ownership and control of its assets are transferred to a chapter 7 trustee for liquidation. The only exception is for individual debtors who can claim some property is "exempt" or not subject to creditor claims under applicable law. The name and contact information for the chapter 7 trustee is provided on the notice sent to creditors, and the trustee can be contacted with questions regarding the case.

Upon any bankruptcy filing, the "automatic stay" under 11 U.S.C. § 362 immediately goes into effect and prohibits action against the debtor or its property, including sending a simple demand letter to the debtor. The debtor or a trustee can sue anyone who violates the automatic stay.

2. If I Have an Ongoing Contract With the Debtor, Do I Have to Perform?
Yes. A non-debtor party to a contract is not excused from performance merely because the other party filed for bankruptcy. A contract that has ongoing obligations on both sides (called an "executory contract") can be "assumed" or "rejected" by the debtor during its case. Until then, the non-debtor party must continue to perform or risk becoming liable for breach. Performance is excused when the contract is rejected, and the non-debtor party can file a motion to compel the debtor to reject the contract if the debtor is not meeting its obligations, such as making lease payments for use of property. In a chapter 7 case, all executory contracts not assumed by the chapter 7 trustee are deemed rejected 60 days after the "petition" or bankruptcy filing date.

If a debtor seeks to "assume" an unexpired lease or other executory contract, it must cure all defaults and accept the contract as is without modification. The cure amount can be negotiated but the non-debtor party is not required to accept anything less. If the proposed cure amount in a notice sent to you is stated as $0 or less than what is actually owed, you must file a formal objection within the time stated in the notice or risk losing your right to insist on a full cure.

3. I Recently Sent Goods to the Debtor, Do I Have Priority or Reclamation Rights?
Yes. Bankruptcy law expands a creditor’s right to reclaim goods from within 10 days of delivery under Uniform Commercial Code § 2-702 to within 45 days of delivery under 11 U.S.C. § 546. The demand for reclamation must be asserted in writing within 20 days after the petition date and can usually be asserted in a letter with a description of the goods that is mailed to the debtor and its attorney. Reclamation rights are subject to the existing claims of secured creditors and goods not in existence or identifiable at the time a demand is made cannot be reclaimed.

Another valuable right afforded creditors under the Bankruptcy Code is a creditor’s right to receive priority payment for goods delivered within 20 days of the petition date. These priority claims are referred to as "20 Day Claims" or "Section 503(b)(9) Claims" based on the relevant Code section. These claims must be asserted in a motion filed with the bankruptcy court. In some large chapter 11 cases, the debtor will seek approval of a specific claim form to be used by creditors asserting these claims in lieu of filing a motion.

4. How Do I Find Out What is Happening in the Bankruptcy Case?
All bankruptcy case dockets are accessible and most pleadings can be downloaded from the internet with a PACER (Public Access to Court Electronic Records) account. Register for a PACER account here. Under current law, a debtor can file for bankruptcy in the jurisdiction in which it was organized or incorporated, or in the jurisdiction in which it primarily operates its business.

All bankruptcy court web sites use a 2 letter state code, followed by the district code if applicable (such as "s" for southern or "c" for central), and end with the letter "b" for bankruptcy. Thus, for example, the bankruptcy court web site for the Southern District of New York is www.nysb.uscourts.gov and for Delaware it is www.deb.uscourts.gov.

If you are an unsecured creditor, you can also contact counsel for the creditor’s committee for current information regarding the case. In most chapter 11 cases, the U.S. Trustee’s office will appoint an "Unsecured Creditor Committee" that can hire attorneys or financial advisors at the debtor’s expense. Contact information for committee counsel is listed at the top of the docket.

5. The Debtor Owes My Company Money for Goods or Services.
If the debtor owes your company for goods or services provided prior to the petition date, you can file a Proof of Claim ("POC") and attach supporting documentation. A POC form is mailed to creditors with the initial case filing notice or can be downloaded from the bankruptcy court’s website. POCs can be filed electronically or mailed to the court. If mailed, include a copy of the POC cover page with a self-addressed, stamped envelope for obtaining verification your claim was received. Most chapter 7 cases are filed as "no asset" cases and the initial case filing notice will state "Please Do Not File a Proof of Claim Unless Instructed To Do So." The chapter 7 trustee will send out notice to creditors and a POC form if assets become available.

The deadline for filing a POC varies by jurisdiction but is usually 90 days after the date scheduled for the "Meeting of Creditors." In some jurisdictions, the claim deadline for a chapter 11 case is set by order of the court. The POC form includes instructions for filling it out and allows you to assert whether your claim is secured by collateral or entitled to priority status. You should consult bankruptcy counsel if you believe you have a secured or priority claim to ensure that your rights are properly protected and preserved.

6. Can I Repossess Collateral that Secures My Claim?
As noted earlier, the automatic stay under 11 U.S.C. § 362 goes into effect immediately upon a debtor’s bankruptcy filing and prohibits a creditor from taking any action to recover collateral. If you hold a lien in the debtor’s property, you need to file a motion seeking relief from the automatic stay before you can enforce rights against the collateral. To the extent your lien was not properly perfected under applicable state law (usually Art. 9 of the UCC), the debtor or a trustee in bankruptcy can seek to avoid your lien leaving the claim unsecured.

You may be entitled to request relief from the automatic stay to recover your collateral (i) if the debtor has no equity in the collateral and it is not necessary for reorganization, or (ii) for "cause" if the debtor has failed to provide you with "adequate protection" to protect the value of your collateral during the debtor’s use in bankruptcy such as by making lease payments.

7. The Debtor Paid My Company for Goods or Services in the Last 90 Days.
If you were paid by the debtor in the 90 days prior to its bankruptcy filing (the "preference period"), you are at risk of being sued for the recovery of a preference. 11 U.S.C. § 547(b) defines a preference as: (i) a transfer of the debtor’s interest in its property, (ii) to or for the benefit of a creditor, (iii) on account of an "antecedent" or pre-existing debt, (iv) made while the debtor was insolvent (there is a presumption of insolvency for the 90-day preference period), and (v) on or within 90 days (or within 1 year for "insiders") prior to the petition date that enables the creditor to receive more than it would in a chapter 7 liquidation.

8. I Have Been Sued for a Preference, What are My Defenses?
The most common defense to a preference claim is that the payment was made and received in the ordinary course of business ("OCB"). The OCB defense can be proven either subjectively (based on prior transactions between the debtor and that creditor) or objectively (using an industry standard often established through expert testimony). Factors which may take a transaction outside the OCB include payments received from collection efforts, payments made either too quickly or too slow as compared to past payments, or payments by uncommon means, such as a cashier’s check or wire transfer. The subsequent "new value" defense is established by demonstrating that the debtor received something of value from the creditor in an otherwise unavoidable transfer after the payment was made (e.g. subsequent shipment of goods). Most jurisdictions recognize this defense even if the creditor was later paid for the new value provided. Other defenses include "contemporaneous exchange of value" for C.O.D. transactions or payments made within a few days of delivery if intended to be substantially contemporaneous, and there is a small preference safe harbor for transfers less than $5,850 (adjusted every 3 years).

Preference lawsuits can be initiated by mailing a summons and adversary complaint to a defendant by regular U.S. mail; personal service is not required. The deadline for responding is 30 days from the date of the summons, provided the complaint was mailed within 10 days of issuance. Most preference lawsuits are settled through the informal exchange of information supporting alleged defenses, such as a spreadsheet for the OCB defense showing a history of invoice, payment and number of days to pay for the time period just prior to the preference period and the preference period, or by sending copies of invoices for goods or services constituting "subsequent new value" given to the debtor after the receipt of any alleged preferential transfer.

9. What Does it Mean When a Company Exits Bankruptcy?
A company "exits" bankruptcy when it has confirmed a chapter 11 plan of reorganization. The bankruptcy case will likely stay open for several months or years after a plan is confirmed while post-confirmation matters are handled, such as suing out preferences and reviewing and objecting to claims and making distributions on claims.

10. When Can I Expect to Receive a Distribution on My Proof of Claim?
Distributions on claims is the last thing to occur before a bankruptcy case is closed and may not occur until several months or years after a chapter 11 debtor has confirmed its plan or sold its assets in bankruptcy. The debtor or trustee must first pursue all claims held by the bankruptcy estate, such as preference or fraudulent transfer claims under federal bankruptcy law or other state or common law claims held by the debtor on the petition date. All proofs of claim are also reviewed for potential objection, including as to claim amount or alleged priority.

The general priority scheme for making distributions on claims under bankruptcy law is as follows: (1) secured claims up to the extent of the value of the collateral, (2) chapter 7 post-conversion priority administrative claims if applicable, (3) chapter 11 priority administrative claims within the order of their priority under 11 U.S.C. § 503, (4) general, unsecured claims, and (5) equity interests in the debtor.

Conclusion
The Bankruptcy Code and bankruptcy proceedings can be complex and intimidating for non-bankruptcy lawyers. However, the above tips should help you to navigate some of the most common issues facing companies who have done business with a person or entity who later files for bankruptcy.

(This article has been republished with permission from ACC.)




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